Peer-to-peer lending could ease banks’ grip

EVERY now and again something comes along that has the power to genuinely disrupt the banking industry.

EVERY now and again something comes along that has the power to genuinely upset the applecart — or should we say gravy train — in the banking industry.

Peer-to-peer (P2P) lending — an internet-enabled technology platform that allows lenders and borrowers to come together independent of the banking system — promises not just to lower borrowing costs but to offer a new form of income for investors willing to place money in the system.

Until very recently it was difficult to get excited about P2P finance in the local market because there was only one significant operator — SocietyOne, which has initially restricted its service wholesale investors.

Now this narrow line of product has been greatly expanded with the arrival in the Australian market of British-based player RateSetter. The group has more than $1 billion on the books in Britain but, more importantly, it is in the business of consumer loans — borrowers must still have good credit scores but retail investors who wish to act as lenders may join the market with entry levels as low as $100, according to managing director Daniel Foggo.

Putting the two services — SocietyOne and RateSetter — together we have the first fledgling shoots of a de facto P2P lending industry on our shores and just in time too.

In the US, P2P is one of the hottest areas of the market with news this week that the pending IPO of Lending Club, a key American player — backed by former US Treasury secretary Larry Summers among others — has raised its offering to $US650m. Lending Club is the largest P2P service in the finance industry, it has facilitated more than $6bn worth of lending since it was founded back in 2007.

At its best this new industry may create an alternative to the banking system. From an investor’s point of view P2P also offers that rarest of alternatives — an income product beyond conventional high-yield securities such as shares or bonds. Foggo says that in Britain one in five lenders in the system are in “pension phase” and the group were attracted to Australia as its first offshore venture due to the rich opportunity presented by the million-member DIY super sector.

The P2P system is far from perfect but it echoes the early days of the securitisation market more than a decade ago when a new form of financing genuinely threatened the major banks with the arrival of Aussie Home Loans and RAMS. Westpac already has bought a stake in SocietyOne.

But, for now, we have a sector that may be entering the golden patch when it is new, innovative and genuinely competitive before the big four get to drain it of entrepreneurial dash — not to mention keen prices.

So how does it work? The system has been chiefly enabled by the provision of credit scores which is what your banker used to have on the desk when you went to them for a loan. With modern technology the P2P brigade can cherrypick the best customers from the banking system, which is exactly what they intend to do in the next few years.

Looking at the numbers at RateSetter it would seem a borrower could be considerably better off. According to a recent survey by the independent rate comparison site Mozo, using the example of a $20,000 three-year loan, the cost of borrowing in P2P “with fees” would cost 10 per cent, rather than a comparative rate of 17 per cent, which would be typical among the banks. That is a very large 7 per cent difference. The example assumes the borrower has a premium credit score.

As for the terms for lenders at RateSetter it would seem an investor placing money into the RateSetter system would get perhaps 7.6 per cent against maybe 3 per cent placing it in a conventional bank online savings account, according to the Mozo survey. As with any new idea there are elevated risks and rewards in these early days. The model does not have a long track record. These operators do not have the prudential regulation of banks. Nor is your money placed in the system enjoying a government backed guarantee.

Anyone entering the area as either a borrower or lender would need to do their homework but at best it would appear to be an idea whose time has come and internet technology is allowing it to happen. Better still, the P2P early movers need only take a slice of the banking market and the oligopoly — ANZ, CBA, NAB and Westpac — will inevitably respond with a more competitive model.

Without doubt, anything that can seriously threaten the cozy grip of the major banks on borrowers — and depositors — is a welcome development.

James Kirby is the managing editor of Eureka Report.